Financial and Managerial Accounting Wild, Shaw, and Chiappetta Fifth Edition Wild, Shaw, and Chiappetta Fifth Edition McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 7 Accounts and Notes Receivable

Conceptual Learning Objectives C1: Describe accounts receivable and how they occur and are recorded. C2: Describe a notes receivable, the computation of its maturity date, and the recording of its existence. C3: Explain how receivables can be converted to cash before maturity. 7-3

Analytical Learning Objectives A1: Compute accounts receivable turnover and use it to help assess financial condition. 7-4

Procedural Learning Objectives P1: Apply the direct write-off method to account for accounts receivable. P2: Apply the allowance method and estimate uncollectibles based on sales and accounts receivable. P3: Record the honoring and dishonoring of a note and adjustments for interest. 7-5

Accounts Receivable Amounts due from customers for credit sales. Credit sales require: MMaintaining a separate account receivable for each customer. AAccounting for bad debts that result from credit sales. C1 7-6

On July 16, Barton, Co. sells $950 of merchandise on credit to Webster Co., and $1,000 of merchandise on account to Matrix, Inc. Sales on Credit and Accounts Receivable Subsidiary Ledger C1 7-7

Sales on Credit and Accounts Receivable Subsidiary Ledger C1 7-8 Subsidiary Ledger Control Account

On July 31, Barton, Co. collects $500 from Webster Co., and $800 from Matrix, Inc. on account. Sales on Credit and Accounts Receivable Subsidiary Ledger C1 7-9

Sales on Credit and Accounts Receivable Subsidiary Ledger C Control Account Subsidiary Ledger

Advantages of allowing customers to use credit cards: Customers’ credit is evaluated by the credit card issuer. The risks of extending credit are transferred to the credit card issuer. Cash collections are quicker. Sales increase by providing payment options to the customer. Credit Card Sales C1 7-11

With some credit cards and nearly all debit cards, the seller deposits the credit card sales receipts in the bank just like it deposits a customer’s check. The bank increases the balance in the company’s checking account. The company usually pays a fee of 1% to 5% of card sales, for the service. Credit Card Sales C1 7-12

On July 16, 2013, Barton Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 2%. The cash is received immediately. Credit Card Sales, Cash Received Immediately on Deposit C1 7-13

On July 16, 2013, Barton Co. has a credit card sale of $500 to a customer. The credit card company charges a processing fee of 2%. Barton remits the credit card sale to the credit card company and waits for the payment that is received on July 28. Credit Card Sales, Cash Received Sometime After Deposit C1 7-14

Installment Accounts Receivable Amounts owed by customers from credit sales for which payment is required in periodic amounts over an extended time period. The customer is usually charged interest, which is the cost for the use of money over time. C1 7-15

Some customers may not pay their account. Uncollectible amounts are referred to as bad debts. There are two methods of accounting for bad debts:  Direct write-off method  Allowance method Some customers may not pay their account. Uncollectible amounts are referred to as bad debts. There are two methods of accounting for bad debts:  Direct write-off method  Allowance method Valuing Accounts Receivable P1/P2 7-16

On August 4, Barton determines it cannot collect $350 from Martin, Inc., a credit customer. Direct Write-Off Method P1 7-17

On September 9, Martin decides to pay $200 of the amount previously written off. Direct Write-Off Method P Direct Write-Off Method

Matching vs. Materiality The matching (expense recognition) principle requires expenses to be reported in the same accounting period as the sales they help produce. The materiality constraint states that an amount can be ignored if its effect on the financial statements is unimportant to users’ business decisions. P1 7-19

At the end of each period, an estimate is made of the total bad debts expected to be realized from that period’s sales. There are two advantages to the allowance method: 1. It records estimated bad debts expense in the period when the related sales are recorded. 2. It reports accounts receivable on the balance sheet at the estimated amount of cash to be collected. At the end of each period, an estimate is made of the total bad debts expected to be realized from that period’s sales. There are two advantages to the allowance method: 1. It records estimated bad debts expense in the period when the related sales are recorded. 2. It reports accounts receivable on the balance sheet at the estimated amount of cash to be collected. Allowance Method P2 7-20

Recording Bad Debts Expense ( under the allowance method) At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2013, is $278,000. P2 Contra-asset account 7-21

Recording Bad Debts Expense At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2013, is $278,000. We report our Accounts Receivable on the balance sheet as shown below. P Recording Bad Debts Expense ( under the allowance method) Net Realizable Value

Two Methods 1.Percent of Sales Method (Income Statement Method); and 2.Accounts Receivable Methods (Balance Sheet Methods) l Percent of Accounts Receivable Method l Aging of Accounts Receivable Method. Two Methods 1.Percent of Sales Method (Income Statement Method); and 2.Accounts Receivable Methods (Balance Sheet Methods) l Percent of Accounts Receivable Method l Aging of Accounts Receivable Method. Estimating Bad Debts Expense P2 7-23

Barton has credit sales of $1,400,000 in Management estimates 0.5% of credit sales will eventually prove uncollectible. What is estimated bad debts expense for 2013? Percent of Sales Method P2 Bad debts expense is computed as follows: 7-24 Percent of Sales Method

Barton’s accountant computes estimated Bad Debts Expense of $7,000. Percent of Sales Method P Percent of Sales Method

 Compute the desired ending balance of the allowance for doubtful accounts.  Bad debts expense is computed as: Percent of Accounts Receivable Method P2 7-26

Barton has $100,000 in Accounts Receivable and an existing $900 credit balance in Allowance for Doubtful Accounts on December 31, (Past experience suggests that 4% of receivables are uncollectible.) What is Barton’s bad debts expense for 2013? Barton has $100,000 in Accounts Receivable and an existing $900 credit balance in Allowance for Doubtful Accounts on December 31, (Past experience suggests that 4% of receivables are uncollectible.) What is Barton’s bad debts expense for 2013? Percent of Accounts Receivable P Percent of Accounts Receivable Method Well, I have to consider the balance in the Allowance Account, so…

Desired ending balance in Allowance for Doubtful Accounts. Percent of Accounts Receivable P Percent of Accounts Receivable Method

 Each receivable is grouped by how long it is past its due date.  Estimated bad debts for each group are totaled.  Each age group is multiplied by its estimated bad debts percentage. P Aging of Accounts Receivable Method

  Aging of Accounts Receivable     P Aging of Accounts Receivable Method Desired Ending Balance

Barton’s unadjusted existing balance in the allowance account is $900. We estimated the desired balance to be $5,320. Barton’s unadjusted existing balance in the allowance account is $900. We estimated the desired balance to be $5,320. Aging of Accounts Receivable P Aging of Accounts Receivable Method

With the allowance method, when an account is determined to be uncollectible, the account is written off against the Allowance for Doubtful Accounts. Writing Off a Bad Debt under the Allowance Method On December 27, Barton determines that Martin’s $300 account is uncollectible. P2 7-32

Subsequent collections of accounts written off require that the original write-off entry be reversed before the cash collection is recorded. Recovery of a Bad Debt Under the Allowance Method P2 7-33

Estimate based on % of Sales Emphasis on Matching Sales Bad Debts Exp. Income Statement Focus Estimate based on % of Receivables Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Estimate based on an Aging of Receivables Emphasis on Realizable Value Accts. Rec. All. for Doubtful Accts. Balance Sheet Focus Summary of Allowance Methods: P2 7-34

$1, July 10, 2013 Ninety days Barton Company, Los Angeles, CA One thousand and no/ Dollars First National Bank of Los Angeles, CA 42 12% Julia Browne after date I promise to pay to the order of Payable at Value received with interest at per annum No. Due Oct. 8, 2013 Term Payee Maker Notes Receivable C2 Principal Interest Rate Due Date 7-35 Date of note

If the note is expressed in days, base a year on 360 days. Even for maturities less than one year, the rate is annualized. Interest Computation C2 7-36

On March 1, 2013, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier. What is the maturity date of the note? On March 1, 2013, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier. What is the maturity date of the note? Computing Maturity Date and Interest C2 7-37

Computing Maturity Date and Interest The note is due and payable on May 30, How much interest will Matrix pay to Office Supplies, Inc. on this note? C2 7-38

Total interest due at May 30. Computing Maturity Date and Interest C2 Principal of the note × Annual interest rate × Time expressed in fraction of a year =Interest $ 12,000 × 9% × 90/360 = $

Recognizing Notes Receivable Here are the entries for Office Supplies Inc. to record the note from Matrix, Inc. on March 1 and the settlement on May 30, C2, P3 7-40

Recording a Dishonored Note On May 30, 2013, Matrix informs us that they are unable to pay the note or interest. P3 7-41

Recording End-of-Period Interest Adjustments On December 1, 2013, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix issued a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, the end of the company’s accounting period? On December 1, 2013, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix issued a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, the end of the company’s accounting period? $12,000 × 9% × 30/360 = $90 P3 7-42

Recording End-of-Period Interest Adjustments Recording collection of note at maturity. P3 7-43

Disposing of Receivables Companies sometimes want to convert receivables to cash before they are due. They can sell or factor receivables. They may pledge receivables as security for a loan C3

This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. Net sales Average accounts receivable, net Net sales Average accounts receivable, net Accounts Receivable Turnover A Accounts receivable turnover =

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